Bond slump could hurt ‘target’ funds

By Matthew Heimer

The great thing about “target-date” mutual funds is that, at least in theory, investors who rely on them never have to tinker with the asset allocation in their retirement portfolios. (The funds gradually shift assets from stocks to bonds as a predetermined retirement date approaches.) That’s one reason that such funds have become staples of 401(k) plans, holding more than $530 billion worth of assets.

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If that’s true, target-date funds could suffer.

The less great thing (one of them, anyway) is that those funds aren’t supposed to deviate from their stock-bond ratios, even when freakish market conditions prevail. That inherent flaw hurt many target-date funds during the 2008 stock-market plunge, and it could hurt them again if bond prices – currently about as high as they’ve ever been, by some measures – come tumbling down in the next few years.

The Wall Street Journal’s Liam Pleven and Joe Light explore this problem in a timely piece this week. The issue is most pressing for shareholders of funds with 2015 and 2020 retirement dates—those are the ones whose portfolios have the most bond exposure, since their shareholders are presumed to be closer to retirement and more averse to the risk of owning equities. Light and Pleven look at several widely owned target-date funds, calculating how much the values of their bond portfolios would fall if the yield on the 10-year Treasury were to double from its current 1.7%. (Sound far-fetched? It isn’t: The most the 10-year yield has risen in any previous 12-month period in the last 50 years was 4.7%, the reporters say.) Funds with higher bond allocations and longer average durations would fare worst, they estimate, losing 9% or more of their bond holdings’ value (Wells Fargo and Vanguard have funds that fall into this category), but even the best of the group would lose at least 6.5%. Not exactly catastrophic, but for someone on the cusp of retirement, not great news either.

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Encore looks at the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities, needs and priorities of people saving for and living in retirement. Our lead blogger is editor Matthew Heimer, and frequent contributors include editor Amy Hoak, writer Catey Hill, and MarketWatch columnists Elizabeth O’Brien, Robert Powell and Andrea Coombes. Encore also features regular commentary from The Wall Street Journal retirement columnists Glenn Ruffenach and Anne Tergesen and the Director of the Center for Retirement Research at Boston College, Alicia H. Munnell.